The Gold Standard - That Never Was

0:00The gold standard has fallen into disgrace among economists, politicians and the interested public alike. This state of affairs may be explained by presumably three factors. First, the prevailing political social ideology, which is in favor of growing government and the welfare state, is irreconcilable with the gold standard or any commodity standard for that matter. And second, mainstream economic theory casts the gold standard as an overcome rigid and inflexible monetary system economically inferior to the modern days fiat money. And third, the consensus among mainstream economists is that the gold standard is to be held responsible for causing severe economic crisis and being a drag on economic expansion.

0:47The last factor, the allegedly bad empirical experience made with the gold standard has has nurtured, perhaps more than anything else, an anti-gold standard sentiment among experts and non-experts alike. However, I argue that such a viewpoint appears to be misinformed, to say the least. The term gold standard has been applied loosely, mostly including those monetary systems which, upon closer scrutiny, proved to be, and I would like to use a phrase by Murray Rothbard, quote, an inflationary system under the cloak of the prestige of gold. The economic and political problems created by, as I call it, a pseudo-gold standard, such as the gold exchange standard or as the system of Bretton Woods, have led many economists, and falsely so, to ascribe the evils to using gold money as such.

1:46The pseudo-gold standards have in common, or what the pseudo-gold standards have in common, is that they violate in one way or the other the principles of the free market. In my article, I want to refute the critique leveled against using gold as money. And what is more, I would argue that gold could actually be the economically and ethically superior or perfect kind of money provided that the gold money standard complies with the principles of the free market and to explain these propositions it will be shown in a first step that the requirements for qualifying as a gold standard for qualifying as a pure gold standard is the money standards compliance with the principles of the free market and this will be done by taking recourse to praxeology and a second step it will be We pointed out as a way of making use of historical experience that the gold exchange standard and the system of Bretton Woods were a monetary standard actually irreconcilable with the

2:52principles of the free market. Now you may know the gold standard has many faces. What it means, the gold standard is typically understood as a monetary system in which money, The universally accepted means of exchange is legally predetermined or fixed weight of gold. For instance, from 1837 the US dollar was defined as equal to 23.22 grains of pure gold and 480 grains in a fine ounce of gold equaled one troy ounce. So the legal price of one ounce of gold was therefore 20.6711 US dollar. So in a gold standard, the name of the currency denotes a physical quantity of gold.

3:38Now there's a gold coin standard. A gold coin standard means that gold coins circulate freely throughout the economy. Gold coins may be freely imported, exported and melted. What is more, bank notes, for instance, and bank deposits, which can be termed money substitutes, are redeemable into gold coins. Another version is the gold bullion standard, which means that only large amounts of banknotes and bank deposits are redeemable into gold, and only in large sized gold bars, so that there is no gold coin as hand-to-hand money. And finally we have the gold exchange standard. Broadly speaking, the gold exchange standard is a monetary standard in which a country links its currency not to gold, but to another currency which is redeemable into gold. I come back to that later.

4:34The term gold standard, as I said earlier, does not necessarily imply that a monetary system is compatible with free market principles though. In fact, the term gold standard has often been applied to monetary regimes that were actually incompatible with the free market principle. Now, the crucial question here is what makes the gold standard compatible with the free market principles? And so, we can take praxeology as a basis for outlining, delineating these principles. As you know, Ludwig von Mises constructed economics along the lines of praxeology, the logic of human action. Praxeology is a priori theory, which means it provides us with irrefutably true knowledge, knowledge which is actually independent of sensory experience.

5:28For instance, we know that value, ends, means, the law of diminishing marginal utility and even private property are categories implied in the axiom of human action. Praxeology does not only provide a priori knowledge as far as economics is concerned, it also allows us deducing a rational ethics or a priori ethics as shown by Hans-Hermann Hoppe. Hoppe deduced property rights ethics from the self-evident axiom of argumentation, which is also called the a priori of argumentation, which is like the axiom of human action, irrefutably true a priori. The Austrian a priori ethics which derives its truth value from a non-hypothetically true axiom allows us also to make use of ethical standards when it comes to evaluating a monetary standard In the following, I try to point out what are the principles of a free market system According to praxeological categories and I would like to start with the work of Carl Menger who put forward in his Principles of Economics a theory of the origin of money and he argued that money emerged spontaneously out of the free market and out of a commodity and this view was confirmed in 1912 by Ludwig von Mises in The Theory of Money and Credit. Mises came forward with the regression theory and showed that it must have been the

7:10Money must have emerged out of a commodity and if that is so it becomes obvious that money is an economic good like any other economic good. The question now is what kind of commodity might become money? Praxeology can only provide a general that is a categorical answer. Mises regression theorem would say that only a commodity could emerge as money, such as precious metal, because a commodity must have had value before it was actually chosen for monetary purposes. Looking at monetary history, the finding is that gold and silver always out-competed other media because of their physical properties.

8:02We also know from praxeology that money is an economic good and this leads us directly to the issue of private property. In a free market, there are only three ways in which a good or private property can be acquired in a non-aggressive way. Homesteading production and voluntary trade. And that said, money is and must be the property of those having rightfully produced it or having received it through voluntary exchange in the free market. This praxeological insight is particularly important when it comes to banking. Economizing men will seek the most convenient and efficient way for holding his money, and this will in turn make money warehouses spring up in the free market, providing customers with, for instance, services for custodian settlement and safeguarding services.

8:56Money warehouses would be active in what may be called deposit banking. They would receive money proper against issuing money warehouse receipts. And in a free market there would also be demand presumably for credit and if and when some people prefer to consume less than their current income and there are also people who would like to spend in excess of their currently available means that you would expect that some form of credit banking would emerge. And so, deposit banks and credit banks would have to be legally separated entities in such a free market and what is more, the money substitutes would have to be backed by 100% of money proper so that money substitute would actually be money certificate.

9:46Engaging in fractional reserve banking that is issuing money substitute backed by less than 100% money proper would be unlawful or fraudulent from a praxeological viewpoint, I would argue. So in a free market there would be free banking, that is there would be a free market entry and market access from any kind of deposit and credit banking business. In a free market you wouldn't have any central bank, it wouldn't comply with the principles of the free market, central banking would not be an element in the free market. You wouldn't have any legal tender rights. You wouldn't have any further government intervention in monetary affairs.

10:31Now, having said that, you would see that most monetary standards we can observe in the past didn't live up to the principles of the free market. They were always heavily interventionist. And so, after having outlined these principles, I would just like to spend some minutes on an illustration of what I just said, and I would like to focus on the gold exchange standard. After the end of World War I, the international monetary and economic order lay in shambles. Most nations had gone off the gold standard at the beginning of the war. The exception was the United States. Great Britain, the nation that was still calling the shots in world financial affairs in the 1920s, decided on 28th of April 1925 to return pound sterling to gold.

11:27However, the plan was not to return to pre-war one kind of gold standard, but to so-called gold exchange standard. The gold exchange standard had two important features. First, Great Britain adopted a gold bullion standard, and second, the British pound was supposed to be the reserve currency along the US dollar for all other European countries. The gold standard created a European credit pyramid, which proved to be unsustainable. The trouble started with Britain deciding to go back to gold at pounds pre-World War I parity at around 4.87 US dollar. A political decision made largely for prestigious and financial reasons. At this rate, the pound sterling was overvalued.

12:14After World War I, the pound sterling rate had gone down to $3.50. So it was actually a price fixing, and that had, of course, severe consequences. An overvalued exchange rate caused trouble for the British economy. It lost international competitiveness. Britain needed lower wages. However such a develop was for political reason not feasible. The British trade balance went into deficits and this in turn let other nations to build up sterling balances which provided banks in these countries with excess reserves and therefore for inflationary developments. And on this chart you see the trade balance of Great Britain from 1880 until 1950.

13:05and you can see in the middle of the 1920s when Britain went back to the gold standard at an overvalued parity, the trade balance went into negative territory, so other countries ran up trade surpluses vis-a-vis Great Britain, thereby receiving additional pound sterling balances which provided them with ammunition for producing additional money and credit.

13:35To prevent the negative trade balance from resulting in a gold drain from Britain or other European nation states participating in the gold exchange standard had been politically induced to use pounds as reserves for increasing the quantity of their own domestic currencies rather than redeeming them into gold at the Bank of England. The gold exchange standard was by construction and inflationary scheme. Team, Murray Rothbard, the gold exchange standard cunningly broke the classical gold standard's stringent limits on monetary and credit expansion. It was not in any way compatible with free market principles. And as you know, the Americans got involved because the Americans started pursuing a very inflationary policy in the 1920s in order to back up the British pound.

14:26The American Federal Reserve embarked on an expansionary inflationary boom policy, which later on resulted in the Great Depression. And the Great Depression reached Europe on 11th May 1931. The Vienna Kreditanstalt, Austria's biggest bank, went under, making Austria going off the gold exchange standard. And the crisis spread to various continental European countries, in particular Germany, reaching Great Britain next and on 21st September 1931 the Bank of England ended the redeemability of British Pounds into gold and the gold standard had collapsed at that time. So I should say the pseudo gold standard had collapsed. So to conclude, maybe I should show you one more graph.

15:17I don't have the time to go into the system of Bretton Woods, but the system of Bretton Woods was also an inflationary scheme where the Federal Reserve expanded the money supply in the United States well beyond gold reserves, official gold reserves, and just to show you the dimension on this graph you see the hypothetical price of gold in dollars if, for instance, The United States would go for 100% coverage of the money stock M1 that would apply a conversion rate into gold of around about $10,000 and the expansion of M2, that's the orange line, would suggest gold convertibility rate of close to $40,000 and much of it has run up during, of course, the system of Bretton Woods Let me just conclude. The failures of the gold exchange standard and the system of Bretton Woods were by no means failures of gold money.

16:24They represent failures of government interventionism in the field of monetary affairs. And to emphasize, the gold exchange standard and the system of Bretton Woods were monetary standards incompatible with the principles of the free market. And yet these failures are used by many economists as evidence or proof against gold money. Praxeology shows that economically and ethically acceptable money is free market money, money that is freely produced and chosen in the unhampered market, 100% reserved banking, no central banking, no meddling with the interest rate through the central bank. Advocates of economically and ethically acceptable money should therefore not call for a return to gold money or a gold money standard for that matter in the first place.

17:11Place. They should first and foremost call for free market money. The freedom to choose would presumably make gold money proper. Thank you very much.